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Has VirnetX Become the Perfect Stock?

http://www.fool.com/investing/general/2013/02/24/has-virnetx-become-the-perfect-stock.aspx

Dan Caplinger
February 24, 2013

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock and then decide whether VirnetX (NYSEMKT: VHC) fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Moneymaking opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, and with the understanding that these factors don't always work well with companies that don't have traditional business models, let's take a closer look at VirnetX.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

54%

Pass

 

1-year revenue growth > 12%

1,343%

Pass

Margins

Gross margin > 35%

100%

Pass

 

Net margin > 15%

NM

NM

Balance sheet

Debt to equity < 50%

0%

Pass

 

Current ratio > 1.3

10.60

Pass

Opportunities

Return on equity > 15%

(40.4%)

Fail

Valuation

Normalized P/E < 20

NM

NM

Dividends

Current yield > 2%

0%

Fail

 

5-year dividend growth > 10%

0%

Fail

       
 

Total score

 

5 out of 8

Source: S&P Capital IQ. NM = not meaningful because of negative earnings and negligible revenue. Total score = number of passes.

Since we looked at VirnetX last year, the company has seen its score climb substantially, largely because of high percentage gains in revenue. Investors have also been optimistic about its prospects, as the stock has risen 50% over the past year.

VirnetX is a company that owns intellectual property related to keeping 4G LTE communications secure. Having obtained those patents from former parent SAIC (NYSE: SAI) seven years ago, VirnetX has spent much of its history in court trying to collect damages from tech companies that VirnetX claims infringed on its technology.

VirnetX has had